With Washington at Impasse, Worry Over Investor Reaction

As Congress and President Obama failed yet again to break their stalemate over the debt limit, Wall Street and Washington turned their attention to a critical question: How long will investors give them?

“We may have a few stressful days coming up — stressful for the markets of the world and the American people,” William M. Daley, the chief of staff for Mr. Obama, said on CBS’s “Face the Nation” Sunday morning.

Early response to the gridlock on Monday indicated continuing worries in global markets, with the dollar losing ground to an index of currencies, United States stocks declining and gold, deemed a safe investment during times of uncertainty, rising.

For weeks, the market for United States Treasuries — long considered the world’s ultimate safe haven — has held relatively steady.

“It wouldn’t be surprising to see a little bit of global reaction to the fact that there’s no sign of an agreement. A sell-off of maybe 1 to 2 percent,” said Fred H. Dickson, chief investment strategist at the Davidson Companies, a brokerage and money management firm in Montana.

It is too soon to know how the stalled progress will play out in the markets all week and whether selling might be even greater.

The Treasury Department has said that the government must reach a deal by Aug. 2 or risk being unable to temporarily meet all its obligations like interest payments on debt, Social Security or paychecks to federal workers.

Few investors believe the United States will renege on its debt. Analysts point out that the government has neared the brink on reaching crucial financial agreements in the past without marketwide collapse. Still, the greatest anxiety in the markets is that investors will lose confidence in Treasuries and move toward selling them, which would drive their values down and their rates up.

John Canavan, a market analyst at Stone & McCarthy Research, a research firm in Princeton, N.J., said that he thinks investors might sell some United States bonds to buy German bonds, or assets in Asia and emerging markets. Foreign investors, he noted, own a far greater share of United States debt than was the case several decades ago.

“They don’t hold them because they have any patriotism or anything else and they’re going to be quick to unload them if they feel there is danger to hold them,” Mr. Canavan said.

Mr. Canavan did not miss a beat when asked when investors would become more nervous. “Now,” he said. “There has been this expectation that at some point, they’d come up with a deal, but given the failure this weekend, I think market confidence is eroding.”

It is often difficult to contemporaneously pinpoint when a panic begins. The financial crisis of 2008, for instance, is often dated to the summer of 2007, but it did not result in full-fledged market chaos for more than a year. During that time, many government officials said the situation was under control.

Photo

William M. Daley, the chief of staff for President Obama, appeared on “Meet the Press” on Sunday to discuss the debt ceiling.Credit
William B. Plowman/NBC News, via Associated Press

The situation in the United States does carry some of the classic ingredients for flurries of selling, financial historians said. Panics sometimes occur when an asset that is considered perfectly safe comes into question. Other conditions for financial mayhem include excessive speculation in a sort of investment — often one thought to be very safe — and sometimes low interest rates.

Some financial historians also believe the markets have become more panic-prone than they once were, in part because of the mass of cash that has poured in recent decades into short-term investments like money market funds.

The current situation is unusual, though, in an important way, said David A. Moss, an economic policy professor at Harvard Business School. Treasuries, he said, are the typical safe haven during a panic, so people might not run away from them.

Mr. Moss said that the outcome could be that there is a “mad rush” out of Treasuries, or it also might be that “people aren’t sure what to do, so they just stay there.”

Treasuries have been at the center of panics in the United States before, though far earlier in American history. Richard Sylla, a finance professor at the Stern School of Business of New York University who has written about panics, pointed to 1792, when one Treasury trader ran into problems and sent the market into a spiral in which it lost 25 percent of its value.

About 100 years later, Congress had to call an emergency session because the Treasury was running out of gold reserves as foreign investors redeemed dollars for gold, Mr. Sylla said.

“Today we talk about what happens if the Chinese sell all the U.S. securities; in 1893, foreign investors were doing just that,” Mr. Sylla said.

Mr. Sylla’s initial assessment of the current situation was, “They’re playing with fire in Washington, D.C., right now.”

Or as the chief of fixed income at Morgan Stanley Smith Barney, Kevin Flanagan, said: “When you’re a bond guy, the thought of default is like Kryptonite. It’s a word you just don’t want to hear.”

Still, perhaps because no one likes to talk in earnest about possible panics, Mr. Moss, Mr. Sylla and Mr. Flanagan said they did think a deal would be reached in Washington before Aug. 2. That would avoid even a technical default, which is a short-term, nonpermanent default that could occur if the government had to delay some payments temporarily while it wrapped up a budget deal.

In addition to watching market signals like interest rates on Treasuries, traders said they were eager to see whether the Treasury Department would announce on Monday that it will decrease the size of this week’s auction of new Treasury securities. The department has been decreasing the size of its weekly auction over the last month, to give it more flexibility if the debt limit is not increased by next week.

Mr. Moss of the Harvard Business School said he did not think that many people were thinking that the nation might enter into an all-out default on its debt and refuse to pay it. But he said a panic could “take on a life of its own” if the Aug. 2 deadline passed, for instance, and if contracts that relied on securities had to be unwound.

When it comes to regular investors, David B. Armstrong, a financial adviser in the Washington area, is not seeing much panic. Of his 125 clients, two called him last week, but none called over the weekend.

“People don’t seem to think that it will end in a default,” said Mr. Armstrong, a managing director of Monument Wealth Management. “Everybody’s talking about it, but no one is panicking about it.”

A version of this article appears in print on July 25, 2011, on page A1 of the New York edition with the headline: With Washington at Impasse, Worry Over Investor Reaction. Order Reprints|Today's Paper|Subscribe